Credit During Bankruptcy

There are many situations when a person needs credit during an open bankruptcy case. Refinancing a home mortgage, redeeming an automobile, or simply applying for a new credit card are circumstances when a debtor needs to obtain credit during bankruptcy. Fortunately, the bankruptcy process allows the debtor to obtain the credit he or she needs while concurrently pursuing a bankruptcy discharge.

When a debtor applies for credit during an open bankruptcy case, the application not only affects the debtor and the creditor, but also concerns the trustee and the bankruptcy court judge. The creditor is concerned that the bankruptcy will interfere with the extension of credit, and the bankruptcy trustee and judge are concerned how the extension of credit will affect the bankruptcy case.

Chapter 7. For Chapter 7 cases, the reach of the bankruptcy court is limited to those assets that you owned and debts that you owed on the date that you filed bankruptcy. The judge does not have jurisdiction on financial matters after the bankruptcy (called “post-petition”). While the bankruptcy court does have jurisdiction to approve or reject a reaffirmation agreement for a pre-petition debt, the court cannot forbid a post-petition extension of credit.

Chapter 13. For Chapter 13 cases, the court has continuing jurisdiction over your finances during the bankruptcy case. A Chapter 13 debtor is required to commit all of his or her disposable income to repay creditors. Any new credit must be approved by the bankruptcy judge since a new payment obligation may impact the Chapter 13 repayment plan.

Vehicle loan. There are no prohibitions to purchasing a vehicle after filing Chapter 7 bankruptcy. Nevertheless, most lenders require that the debtor receive a Chapter 7 discharge prior to extending financing for the vehicle. The main reason for this is the potential for the vehicle and the loan to become involved in litigation. For instance, prior to receiving a discharge, the debtor may convert the case to Chapter 13, or dismiss and re-file, and attempt to modify some terms of the vehicle note (for instance, the change the interest rate or stretch the payment terms).

Obtaining a vehicle during Chapter 13 bankruptcy requires that the debtor show that the vehicle purchase is “necessary to the completion of the Chapter 13 bankruptcy plan.” In plain language, you need the car to get to work to make the money to pay the creditors in the plan. When a vehicle purchase is reasonable and necessary, the courts are generally willing to approve the purchase on credit.

Home loan. Purchasing a home during an open Chapter 13 bankruptcy is difficult, but not impossible. While individual lenders will have different approval guidelines, the debtor must first qualify for an FHA or VA guaranteed home loan, which requires:

  1. written approval from the trustee and bankruptcy court for the new credit; 
  2. a 12 month history of perfect payments on a confirmed bankruptcy plan; and
  3. no further derogatory credit entries after the bankruptcy was filed.

Home loan modification under the federal Home Affordable Refinance Program (HAMP) is specifically authorized during Chapter 13 bankruptcy. This modification of a secured debt in bankruptcy requires the permission of the bankruptcy court and trustee, and will require the debtor to amend the Chapter 13 repayment plan. One recent trend is for local courts to require mortgage mediation sessions or other court supervised processes between the debtor and lender before a loan modification may be approved.

Purchasing a home after filing a Chapter 7 bankruptcy requires re-establishing your financial profile by showing a responsible use of credit. Generally that means two to four years of rebuilding, but in some cases the wait may be shortened.